As a trusted financial professional, you’ve worked with your clients throughout their careers to help them develop a comprehensive retirement savings strategy. This likely includes guidance on the full range of savings options, from company-sponsored plans like 401(k)s to personal accounts such as IRAs. Chances are the bulk of their savings are in these types of tax-deferred plans, which, for the time being, are free from income tax if they do not take withdrawals.

But as your clients approach their 70^th birthday, it’s important they understand that they’ll soon be required to take withdrawals—required minimum distributions, or RMDs—from those funds on an annual basis (unless they are still working and their qualified plan from their employer doesn’t require distributions). They will be taxed on any part of their RMD which has not already been taxed.

But, what if they don’t need those RMDs for everyday living expenses?

According to the RMD Options Study* from Allianz Life Insurance Company of North America (Allianz Life), many people don’t foresee needing all of their RMDs for immediate use. While a majority (88 percent) of high-net-worth consumers ages 65-75 who were surveyed said they are familiar with RMD rules on tax-deferred retirement plans, a full 80 percent of these respondents believe they will not need all of their RMDs for day-to-day living expenses.

Furthermore, respondents reported being more interested in tax-deferred growth of their distributions and reducing taxes. The vast majority (95 percent) said it is very important to minimize their tax burden in retirement, yet nearly a third (32 percent) say they have difficulty understanding how RMDs could impact their overall tax obligation. Not surprisingly, 83 percent of consumers said they hate paying taxes on their RMDs that come out of most tax-deferred retirement plans, which are calculated as income tax.

Plus, many of the older consumers were interested in leaving a legacy. While half of the study respondents said they are interested in leaving a significant portion of their savings to beneficiaries, older consumers in the study (age 71-75) are even more likely (58 percent) to want to leave a legacy.

RMD Requirements

So, what exactly are RMDs and what are some of the requirements?

Required minimum distributions are mandatory withdrawals from many different types of qualified retirement savings vehicles, some of which include traditional IRAs, Simplified Employee Pension IRA plans, profit-sharing plans and defined benefit pension plans. RMDs are not required for Roth IRAs, nonqualified deferred compensations plans, nonqualified annuities and other nonqualified accounts.

Your clients are generally required to take their first RMD when they turn age 70½. They can delay their initial RMD payment until April 1 of the year following the year in which they turn 70½ or retire. For all subsequent years, their RMD is due by December 31 of the year. If they delay their first RMD between January and April 1 of the year following the year they turn age 70½ or retire, they would be taking two RMDs in the second year.

Make sure your clients understand that nonqualified, similar to Roth IRAs, are accounts, plans or annuities that are originally funded with after-tax dollars. Unlike Roth IRAs, however, the earnings or gains may be taxed at the time of withdrawal or during accumulation.

All retirement plans don’t have the same RMD required beginning dates. Traditional IRAs, SEP IRAs and SIMPLE IRAs require first RMD by April 1 of the year following the year the IRA owner turns age 70½, regardless if employed. Qualified plans such as pensions, profit-sharing, and 401(k)s, 403(b) plans, and governmental 457(b) plans have the RMD required beginning date (RBD) at the later of retirement or age 70½.

403(b) plans are a bit more complex. Contributions and earnings after 1986 are subject to RMDs at the later of retirement or age 70½. Balances as of 12/31/86 are subject to RMDs at the later of retirement or age 75. Also, there are a few exceptions such as for 5 percent owners.

Calculating The RMD

To calculate an RMD, your client would take the value of the tax-deferred retirement plan or IRA as of December 31 last year, and divide it by their life expectancy factor. That amount equals their RMD.

The Internal Revenue Service (IRS) provides life expectancy tables to use in the calculation. These include Joint and Last Survivor Table, Uniform Lifetime Table and Single Life Expectancy Table. Clients should use the table that properly applies to their situation. The IRS publishes these tables in their publication 590-B, “Distributions from Individual Retirement Arrangements,” and also provides worksheets to help with the calculations.

Although the IRA provider is required to either provide an estimated RMD amount or offer to calculate the RMD amount for your client, your client bears the ultimate responsibility for ensuring the correct amount is distributed to them. For this reason you may want to encourage them to consult a CPA or other tax professional.

Tax Implications

RMDs with traditional IRAs have several tax implications that your clients should consider. Traditional IRAs basically have three stages for distributions to the IRA owner:

1. Early distributions—the distributions that occur prior to the IRA owner turning age 59½. These may be subject to an early distribution 10 percent federal additional tax unless an exception applies.

2. Normal distributions occur between ages 59½ and 70½. RMDs are not required yet and there is no 10 percent federal additional tax.

3. After age 70½ required minimum distributions (RMDs) start.

If your clients fail to take their RMD, the federal government will impose a 50 percent excise tax for the amount not taken.

The RMD amount will be taxed as ordinary income. That means the withdrawals will be added to your client’s total taxable income for the year, taxed according to their individual federal income tax rate, and may also be subject to state and local taxes.

If your clients have an IRA and made nondeductible contributions, their RMD is based on the total value of the IRA. The RMD calculation is not affected by whether amounts in the IRA are pre-tax or after-tax.

Keep in mind: an increase in income could put your clients in a higher tax bracket and impact the taxes they pay on their Social Security or benefits or cause their Medicare premiums to increase. Your clients should consult their tax advisor for questions about their specific tax situation.

Different Plans, Different Rules

There are some exceptions to RMD rules for certain plans, and a working exception is one of them. If your clients are participating in a qualified plan with their employer and the plan allows it, they can delay their first RMD until the year they retire. If your client uses the working exception and eventually retires, their RMD is due the year they retire. If they use the working exception and terminate employment for any reason, their RMD is due their last year of employment—even if their last day is December 31!

Some exceptions are: If the plan does not allow for extended RBDs or if the individual owns 5 percent or more of their employer company, then RMDs must be taken for the year they turn age 70½.

Note that there are special rules for 401(k) plans. There is an age 70½ exemption if an individual is still working and they are not required by the IRS to take RMDs from their current employer’s plan. However, the taxpayer must take their RMD at age 70½ from any previous employer’s plans, all traditional, SEP and SIMPLE IRAs owned as well as applicable RMD arrangements.

In addition, the employee who is receiving RMDs from that employer’s 401(k) plan must have the option to continue making salary deferrals as long as the plan allows it. The 401(k) employer also must continue contributions for an employee who is receiving RMDs from the plan.

Because an RMD from a Section 401(k) or other qualified retirement plan is not able to be rolled over, it is NOT subject to mandatory federal income tax withholding of 20 percent.

Exploring RMD Options

It’s important to have a discussion with your clients about RMDs as they relate to retirement income strategy. RMDs are required by the IRS, but there are several options to consider if your client’s don’t need their RMDs for income—here are a few options:

Essential expenses: Your clients could use their RMDs for essential expenses since they have to withdraw them anyway. Clients could consider annuities and life insurance products with options for lifetime income.

Discretionary expenses: Maybe your clients need the money in the future for some discretionary expenses. They could set up a future stream of payments using their RMDs. Or they could fund a qualified longevity annuity contract (QLAC), and defer RMDs on a portion of the IRA to provide some longevity protection with future guaranteed income.

Legacy: If your clients wish to leave a legacy, their RMD may be a great mechanism for funding it. Clients can use life insurance policies, including universal or whole life or policies with second-to-die options that might further leverage the RMDs with a spouse. They may also want to fund a non- qualified annuity contract that could, once again, take advantage of tax deferral until the owner passes away.

If they don’t need the income and are contributing to charity, then your clients could consider sending their RMD to their favorite charities.

If your clients don’t need the income and if they meet certain requirements, they can make a qualified charitable distribution (QCD). QCDs have become more popular as a way for retirees to donate money to their favorite charity while possibly lowering their Federal tax obligation. The Tax Cuts and Jobs Act (TCJA) of 2017 nearly doubled the standard deduction to $12,000 for a single person and $24,000 for a married couple filing jointly. As a result, it is likely more taxpayers will take the standard deduction instead of itemizing, and therefore be unable to deduct their charitable contributions. This is where a QCD can help.

Beginning in the year they turn age 70½, your clients can make a QCD directly from the traditional IRA in amounts up to $100,000 per year. By using a QCD, taxpayers can use all or part of the RMD to make charitable contributions directly to a charity of their choice and exclude the contribution amount from income. A QCD allows clients to satisfy RMD requirements while contributing to charity and simultaneously saving money on taxes.

Certain rules apply for a QCD:

• Only distributions from traditional IRAs are eligible

• At the time of distribution, the IRA owner must actually be age 70½ or older

• An annual maximum dollar amount of $100,000 per taxpayer

• QCDs can be greater than the RMD amount

• Distributions must go to public charity

• Distribution checks made payable to charity

Additional Strategies:

• If your client needs the RMD for income, they could set up a future stream of payments using their RMDs. Or they could fund a qualified longevity annuity contract (QLAC), which allows a portion of the IRA to be invested and deferred from current RMD calculations to provide some longevity protection with future guaranteed income starting as late as age 85.

• Grandparent clients might want to consider starting an annual gifting program prior to RMDs or when RMDs are due, which would provide current gifts or, through a trust or non-qualified annuity, a legacy for children and grandchildren.

• Fund grandchildren’s educations with IRA distributions. The latest tax reform laws allow utilization of 529 plans and other education savings plans to pay for elementary, secondary or postsecondary education.

• A Roth IRA conversion may be an option, especially now with the lower tax rates over the next eight years due to the Tax Cuts and Jobs Act of 2017. This option could help your clients manage their tax bracket to minimize taxes due. Note that RMD amounts cannot be converted.

• And finally, another option may be for your clients to minimize future RMD amounts by taking distributions before they are due. Reducing future RMDS may help minimize their effect on Social Security taxation, Medicare premiums and higher taxes during retirement.

As you can see, there is a lot for your clients to consider when making the most of their RMDs. Some proactive next steps you can take with them include reviewing their overall retirement income strategy to see where RMDs may play a role and also helping them consider various options for unneeded RMDs.

Start by identifying which clients are nearing the age for RMDs and have the retirement income conversation now. It’s never too early to help clients begin preparing strategies for their RMDs and overall retirement income needs.

*Allianz Life Insurance Company of North America conducted an online survey. The RMD Options Study was conducted in February/March 2018, and included a nationally representative sample of 805 respondents ages 65-75 with retirement savings of $500,000 if single or $750,000 if married and who are the primary decision maker or share equally in decision making.

Kelly LaVigne is VP of advanced markets for Allianz Life Insurance Company of North America.